Why I’m Not Investing in Bitcoin (BTC)…Yet
I’ve felt the FOMO, like anyone else who has watched the price of Bitcoin (BTC) rise precipitously time and again the last few years and heard the claims of the riches it provides. I’ve watched athletes and celebrities endorse it, like Matt Damon uttering, “fortune favors the brave” in a prime-time commercial ad spot. Yet, for all of the big gains, there have been just as many steep declines. For many, the allure of BTC and other cryptocurrencies is the prospect of sudden wealth, but in reality, that’s not everyone’s experience. Even for those who have, the odds are not in their favor. The suddenly wealthy are often “blindsided by their newfound burdens,” according to Stephen Goldbart, a psychologist who coined the term Sudden Wealth Syndrome (SWS).
Despite my FOMO, I don’t believe BTC is an appropriate allocation for the vast majority of investors because there’s no reliable evidence yet that it helps them achieve their goals.
Here’s why.
1) BTC has no expected return.
The primary goal of many investors is expected return, which is (hopefully) the profit an investor expects from a particular investment. In the case of owning a stock, it’s the idea that you can stake a claim on the future cash flow of that company. With stocks, bonds, and real estate, there is a clear framework to evaluate expected return. Furthermore, there’s nearly a century of historical pricing data on stocks, which is also a significant factor in the academic pursuit to understand expected return.
However, BTC generates no cash flow, and there are no underlying assets. As a result, determining the likelihood of profiting from BTC proves difficult. Supply and demand dynamics drive BTC’s price movement. Many BTC advocates point to its limited supply as an attractive feature. Even so, its limited supply hasn’t dampened its severe volatility to this point. Regardless, attempting to capitalize on the supply and demand dynamics is like trying to grasp water in your hands.
If my goal is to generate a return on my investment in order to reach a particular goal, BTC does not help me. Why? Because even if I invest regularly into BTC, I have no basis for knowing if it will provide me any sort of predictable return in the short or long term.
2) BTC doesn’t mitigate uncertainty or provide reliable liquidity.
The two other main goals of investors are mitigating uncertainty and liquidity provision. In short, investors want to be as sure as possible and have the smoothest path possible to their expected return. Likewise, investors want to know that the part of their portfolio dedicated to liquidity is reliable. That way, when cash is needed for short term expenditures, they are not withdrawing more of their portfolio than was expected.
The reality is there’s not yet a clear understanding of how to categorize BTC. Claims have been made that BTC is describable as “digital gold”, a “store of value”, or an “inflation hedge”. Based on the historical price movements (volatility) of BTC, there’s no evidence that BTC fits any of those descriptions. In fact, based on historical prices, I suggest investors should expect BTC to increase the uncertainty of an investment portfolio, not to mention that it is unreliable for short term expenditures. BTC has taken one of its infamous dips here in the first half of 2022, despite record high inflation. Take a look at the bar graph below to see the number of days in each of the last 5 years that BTC has fluctuated more than two deviations away from its average:
BTC’s price movements are still as severe as they were 5 years ago, despite becoming “mainstream” in 2021, as this Bloomberg article points out.
At Redeem Wealth, we believe financial planning drives investment strategy. So when an investment portfolio has unnecessary uncertainty, that means achieving a client’s goals are less predictable. With historical 10% price movements in a day (or 80% drops in a matter of months) not being entirely uncommon, uncertainty is the name of BTC’s game. There are other facets of BTC’s uncertainty that ought to be mentioned too, such as its technological and economic viability, political risk, and environmental impact. While I can’t dive into those in this blog, they are not factors to be ignored.
3) BTC is the face of Decentralized Finance (DeFi), and DeFi has its pitfalls.
A supplemental reason I’m not investing in BTC is, by definition, it lacks regulation. Decentralization opens up a lot of potential positive outcomes, but it also leaves an uncomfortable amount of room for bad actors.
Many people have been taken advantage of by “pump and dump” schemes, like the ones mentioned in this article. There’s also various stories of investors who have been locked out of their crypto wallets because they can’t remember their password, such as this one, about a man unable to reach his $321M worth of crypto. Even if you manage to remember your password, there’s many examples of hackers accessing crypto wallets, like this example in Forbes. A recent example of abuse is this story about the bankruptcy of a major cryptocurrency firm, Celsius. The firm advertised 19% APY to customers who held crypto on their platform. Customer accounts were not insured, so as a result of the bankruptcy proceedings, Celsius halted customer withdrawals and account activity. As much as bureaucracy and layers of regulation can be a drag, they exist for specific reasons. In many cases, that’s to ensure that exploitation doesn’t happen.
Financial exploitation is typically arrived at by a consumer’s desire to “get-rich quick”. Combine that with a perpetrator’s ability to leverage a consumer’s assets to line their own pockets with no checks and balances. This is why I’m immediately skeptical of anything that hints at a promise to “get-rich-quick”, which is a red flag for exploitation. Not only that, I value the process and habits of wealth-building more than a quick outcome. I know that those behaviors will enable me to become more of the type of person I want to be. In the scenario of long-term wealth building, I’m much more likely to steward the wealth in my care.
Crypto’s future, with critical innovation, is a bright one.
Despite all of these reasons, I’m hopeful there will eventually be a rightful place for crypto in investment portfolios. With more history, it will be easier to do research and come to reliable conclusions about BTC pricing. Blockchain technology and smart contracts have the potential to provide immense value and utility across virtually every industry. As these applications are refined and implemented, this will no doubt have trickle down effects on the viability of cryptocurrencies as investments. Additionally, as explained in this article published by the Center for American Progress, the high cost of transactions is another barrier to making cryptocurrency more inclusive and beneficial to all types of investors.
I came across a profound quote from Robert Cohen, the Chief of the Securities & Exchange Commission’s (SEC) Cyber Unit, in this great blog post on DeFi by Donovan Brooks, CFP and owner of Storyline Financial Planning:
“Using any blockchain to create an exchange without central operations doesn’t remove the original creator’s responsibility… The focus is not on the label you put on something or the technology you’re using. The focus is on the function, and what the platform is doing. Whether it’s decentralized or not, whether it’s on a smart contract or not, what matters is it’s an exchange.”
The heart of this matter is this: there will always be the need for responsibility and accountability in an exchange. While a transparent and public ledger is a compelling concept, what happens when there’s abuse? What are the processes for accountability? When these and other important questions are answered, like some of the ones I’ve raised in this blog post - I’m hopeful that BTC and other cryptocurrencies will become an effective tool for building wealth. The moment there’s compelling evidence for this, I’ll be the first to change my mind.
